Local authorities reacted angrily today to accusations that they acted negligently by depositing almost £33m of taxpayers' money in Icelandic banks just days before their collapse in October.

The Audit Commission found fundamental accountancy mistakes had been made by seven councils: Kent, the London borough of Havering, Redcar and Cleveland, Bridgnorth, North East Lincolnshire, Restormel (Cornwall), and the South Yorkshire pensions authority.

The local government spending watchdog said the councils breached accountancy procedures and failed to follow their own protocols when they deposited £32.8m in the Glitnir and Landsbanki banks between 1 and 3 October 2008. The banks collapsed on 7 October.

But Rita Greenwood, the finance officer at Havering council, today denied the commission's allegations. She said the council made a deposit in an Icelandic bank 20 minutes before an alert went out which downgraded the banks to a lower security rating.

"We refute being called negligent. We rely on [credit] ratings done by established international organisations such as Fitch and Moody's and we were absolutely following all our policies and procedures," she told BBC Radio 4's Today programme.

Greenwood said the timing of the alert on the Icelandic banks had been verified by accountants PricewaterhouseCoopers, adding: "The Audit Commission report fails to give the true facts."

The commission said that in Kent a council official failed to open an email warning that the banks' credit rating had been downgraded before depositing more money. A second council based its investment decision on out-of-date information and a third exceeded its agreed limit for deposits in a single bank.

Nick Chard, Kent county council's cabinet member for finance, said: "The position and language used by the Audit Commission is quite extraordinary; it really is a case of the pot calling the kettle black. The Audit Commission's own internal report stated that they were not aware of the potential problems with Icelandic banks until Monday 6 October 2008; yet they are highly critical of local authorities making deposits after April 2008."

He accused the commission of putting up a "smokescreen" to hide the fact that it had twice the level of exposure in Icelandic banks as Kent council – the commission has 18% of its total deposits in Icelandic banks compared with Kent's 9%. "In terms of getting the money back we remain confident and optimistic that as a preferred creditor we will be first in the queue," Chard said.

Most councils responded to warnings from credit agencies about the increased risk of investing money in Icelandic banks and removed more than £1bn in spring and summer last year.

Yet 127 English local authorities still had £954m deposited with the two banks when they went into administration. This amounted to 3.1% of the total funds held on deposit by English authorities.

For 18 of the authorities, the sums at stake were worth more than the total value of their reserves. The commission said some councils had been locked into investments and could not have withdrawn funds without incurring heavy penalties. But others continued to put money into Iceland after last April, when the Fitch rating agency put all Icelandic banks on a "negative watch" rating.

The commission noted: "Had all local authorities stopped placing deposits in the Icelandic banks in April 2008, the total amount of funds at risk when the banks collapsed in October would have been £389m instead of £954m."

The watchdog acknowledged it had itself invested £10m in Iceland but said this did not compromise its ability to analyse other organisations' mistakes. A spokeswoman said the commission's investments had been made in April and July last year, before the banks' credit rating had been downgraded.

The Icelandic banking collapse exposed the "variable" standards of treasury management in local authorities, the commission said. "Good treasury managers recognised those risks and managed them appropriately. Others either did not appreciate the risks, or underestimated their significance."

Steve Bundred, the commission's chief executive, said: "The circumstances leading up to the collapse of Icelandic banks were highly exceptional, but the potential loss of nearly a billion pounds is of great concern ... There are lessons that must be learned by everyone."

John Healey, the local government minister, said: "This money isn't lost, but it is at risk. So under normal financial rules this risk would need to be taken into account in their budgets, with potentially serious impacts on council tax or services. That's why I recently took the exceptional step to give authorities some breathing space that should allow them to be clearer [about] what sums, if any, are still at risk before accounting for them. This action means services don't need to be cut and council tax does not need to be raised because of uncertainty about these investments."

The Local Government Association said councils expected to get back the "lion's share" of their Icelandic investments.